3 Things That Could Derail the Stock Market in the Second Half of 2021

By: Wayne Duggan

The S&P 500’s momentum off the March 2020 pandemic lows carried over into the first half of 2021, and the S&P finished the first half of the year up another 14.4% — at new all-time highs. At this point, a reopening economy and pent-up consumer demand have investors feeling optimistic about the second half of the year as well.

While there may be more room to the upside in the next two quarters, investors should monitor risks. Here are three things that could potentially derail the bull market in the second half of 2021.

Inflation
Inflation has been one of the biggest concerns on Wall Street in recent quarters after the U.S. government pumped more than $6 trillion in stimulus into the economy since the beginning of 2020. In late June, the U.S. Commerce Department reported the personal consumption expenditures (PCE) price index gained 3.4% in May, its largest year-over-year increase since April 1992. The PCE index is the Federal Reserve’s preferred measure of inflation, and a 3.4% gain is well above the Fed’s long-term inflation target of 2%.

The Fed insists the current inflationary environment is “transitory” as the economy opens up to full capacity. However, if inflation levels continue to rise, it could ultimately force the Fed’s hand in raising interest rates.

Investors should pay particularly close attention to oil prices, which recently hit their highest levels since 2018. Sustained rapid increases in oil prices have been a common U.S. recession indicator in the past.

Policy Changes
Investors initially cheered the prospect of a nearly $1 trillion bipartisan infrastructure spending bill. President Joe Biden has recently said he would not sign the infrastructure bill unless it includes certain “social infrastructure” policies that would be funded in large part by tax increases.

Biden has previously proposed raising the top income tax rate from 37% to 39.6% and increasing capital gains taxes on Americans earning more than $1 million per year from a maximum of 23.8% to a maximum of 43.4%. He has also proposed increasing the U.S. corporate tax rate from 21% to 28%.

Higher taxes would likely mean lower corporate profits and potentially lower stock prices.

2022 Guidance
Analysts forecast full-year 2021 S&P 500 earnings per share to rise 34.8% and revenue to grow by 12.1%. However, those impressive growth numbers are calculated off of depressed pandemic levels. In the second half of the year, investors may be much more concerned with companies’ 2022 guidance and how much of their 2021 growth is sustainable in the long term.

Analysts are currently calling for another 11.8% earnings growth in 2022. If tax cuts, interest rate hikes or lackluster organic earnings growth lead companies to issue lower-than-expected 2022 guidance in the next two quarters, the S&P 500’s valuation may correct accordingly.

Disclosure: The author holds no positions in the securities mentioned.

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